Treasury Yields Slide Again After Fed’s Pivot

On Wednesday, the Federal Reserve maintained its key interest rate unchanged for the third consecutive time. As inflation subsides and the US economy remains resilient, the Federal Open Market Committee's policymakers unanimously voted to retain the benchmark overnight borrowing rate within the target range of 5.25%-5.5%.

In tandem with this decision, Committee members indicated a minimum of three rate cuts in 2024, presuming increments of 25 basis points. This is clearly less than what the market anticipated (Dec-2024 Fed Fund futures at 95.985). Yet this is a bolder approach than officials had earlier suggested. Beyond the announced rate cuts, another key issue next year will be the policy pursued by the Federal Reserve on the size of its balance sheet, which declined by 770 billion in 2023 as shown below:

US Treasury yields sank after the Fed’s dovish signals. The yield on the US 2-year Treasury lost 28 basis points for the week to 4.45% while the yield on the 10-year Treasury was down 33 basis points to 3.92%, returning to its July level.

In Europe, Treasury yields followed suit with the 10-year German bund yield down 26 basis points week-over-week to 2.02% from 2.28%. However, the ECB Governing Council said in a statement that its future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary. The three key ECB interest rates are kept unchanged for the second meeting in a row, as the ECB has revised its growth forecasts lower while announcing plans to shrink its balance sheet. This hawkish tone is somewhat difficult to understand considering that Eurozone year-on-year inflation fell to 2.4% in the most recent reading in November, and the European economy is flirting with recession. Continuing to shrink the central bank's balance sheet could generate a recessionary effect on the economy, even though it has already been reduced by €1,500 billion over the last twelve months.

For now, investor enthusiasm following the Fed's announcements has fuelled the bond rally.

The IBOXX € Liquid Corporates gained 1.71% over the week. In the U.S., the IBOXX $ Domestic Corporates index jumped 2.80%, its strongest gain since November 2022. High yield bonds notched an eighth positive week in a row in Europe, with a gain of 1.31% (IBOXX € Liquid High Yield Index) while their American peers rose 1.99% (Markit iBoxx USD Liquid High Yield Capped Index). Lastly, emerging debt in local currencies was up 1.84% while the greenback was losing momentum (the dollar index down 1.4% over the week).

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